Oil Hits 12-Year Low: Short Energy Stocks With ETFs

by: Zacks Funds

No doubt, last year's chaos in the energy sector has spilled over into this year with many stocks piling up heavy losses in the first couple of weeks of 2016. In fact, the worries have deepened this year with renewed concerns over the slowdown in the world's second-largest economy and the Iran sanctions' lift off.

This is especially true, as the relaxation in sanctions would add a fresh stock of oil in the global market, which is already facing a supply glut. Iran, a member of the Organization of the Petroleum Exporting Countries (OPEC), is expected to increase its crude oil exports by half a million barrels a day immediately and a million barrels a day within a year of lifting the ban.

Though the Iran sanctions were widely expected and the development of oil in the country will take some time to fully ramp up after 40 years, the move unnerved investors, spreading panic among them.

That being said, oil price tumbled to a level not seen in more than 12 years with U.S. crude plunging below $29 per barrel and Brent slumping to below $28 per barrel. From a year-to-date look, oil price has lost more than 20% this year, representing the worst two-week decline since the 2008 financial crisis (read: 4 Country ETFs to Gain from Oil Price Crash).

Trend Remains Weak

Currently, the outlook for oil and energy sector seems gloomy. This is because oil production has risen worldwide with the OPEC continuing to pump near-record levels, and higher output from the likes of U.S., Iran and Libya. Additionally, a strengthening U.S. dollar backed by a rate hike is making dollar-denominated assets more expensive for foreign investors and thus dampening the appeal for oil.

In particular, it will make the borrowings for high-yield firms costlier and result in less money flows into capital-intensive shale oil and gas drilling projects. This in turn will lead to higher bankruptcies, which would hit the already battered energy sector.

On the other hand, demand for oil across the globe looks tepid given slower growth in most developed and developing economies. In particular, persistent weakness in the world's biggest consumer of energy - China - will continue to weigh on the demand outlook. The negative demand/supply imbalance would push oil prices and the stocks further down at least in the short term.

Moreover, the ultra-popular United States Oil Fund (NYSEARCA:USO), tracking the price of US light crude with an asset base of around $2.2 billion and average daily volume of around 32.3 million shares, has hit new all-time lows several times this year. Given the continued sell-off and the bearish outlook, the appeal for energy ETFs is dulling (read: Oil and Energy ETFs That Hit All-Time Lows).

As a result, investors who are bearish on oil right now may want to consider a near-term short on the energy sector. Fortunately, with ETFs, this is quite easy as there are many options to accomplish this task. Below we highlight them and state how each stands out among the rest:

ProShares Short Oil & Gas ETF (NYSEARCA:DDG)

This fund provides unleveraged inverse (or opposite) exposure to the daily performance of the Dow Jones U.S. Oil & Gas Index. The ETF makes a profit when the energy stocks decline and is suitable for hedging purposes against the fall of these stocks. The product has amassed $14.1 million in AUM while volume is light at under 10,000 shares. Expense ratio comes in at 0.95%. It has added nearly 10% so far this year.

ProShares UltraShort Oil & Gas ETF (NYSEARCA:DUG)

This fund seeks two times (2x) leveraged inverse exposure to the Dow Jones U.S. Oil & Gas Index, charging 95 bps in fees. It has amassed $46.1 million in its asset base and trades in good volume of more than 183,000 shares per day on average. DUG returned 19.8% in the first couple of weeks of 2016.

Direxion Daily Energy Bear 3x Shares ETF (NYSEARCA:ERY)

This product provides three times (3x) inverse exposure to the Energy Select Sector Index. Though it charges the same annual fee of 95 bps, it is extremely popular and trades in heavy volume nearly 1.7 million shares. The fund has a decent AUM of $74 million and has gained 32% so far this year.

Direxion Daily S&P Oil & Gas Exp. & Prod. Bear 3x Shares ETF (NYSEARCA:DRIP)

This ETF provides three times bearish exposure to the oil & gas exploration and production corner of the broad energy space tracking the S&P Oil & Gas Exploration & Production Select Industry Index. It has accumulated $6.1 million in its asset base while trades in a lower volume of 32,000 shares per day on average. The fund charges 95 bps in annual fees and has gained 62.9% since the start of the year.

ProShares UltraShort Oil & Gas Exploration & Production ETF (NYSEARCA:SOP)

This fund seeks two times inverse exposure to the S&P Oil & Gas Exploration & Production Select Industry Index, charging 95 bps in fees. It failed to garner enough investor interest with AUM of just $4.6 million and sees a paltry volume of about 3,000 shares a day. SOP is up 40.6% in the year-to-date timeframe.

Bottom Line

As a caveat, investors should note that such products are suitable only for short-term traders as these are rebalanced on a daily basis.

Still, for ETF investors who are bearish on the energy sector for the near term, either of the above products could make an interesting choice. Clearly, a near-term short could be intriguing for those with high-risk tolerance, and a belief that the "trend is the friend" in this corner of the investing world.

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